Small Banks Are Eager to Profit from Rivals' Failures

The big national banks get most of the attention, but it turns out that small banks are even more interested than their larger competitors when it comes to snapping up failed former rivals.

Indeed, 46% of small banks say they're interested in being bidders for failed banks' assets or deposits, compared with just 36% of large banks, according to Grant Thornton's new 17th Bank Executive Survey, conducted in conjunction with Bank Director magazine. Small banks also report more interest in learning more about the process versus their bigger competitors, by 21% to 15%. And the majority of all bank executives, 62%, say their institution is interested in pursuing a failed bank.

After all, plenty of opportunity is out there. Bank failures increased nearly 500% in 2009 versus 2008, accounting for about 70% of total bank failures over the last decade, according to Grant Thornton. The big question now is whether 2010 will see continued wreckage. Unfortunately, it could get ugly.
More Banks Are Teetering On The Edge

The number of insured institutions on the FDIC's "Problem List" -- or banks that are vulnerable -- continues to grow. At the end of September 2009 there were 552 insured institutions on the list, representing nearly $346 billion in total assets. That's more than twice the 2008 year-end stats, which listed 252 insured institutions representing $159 billion in total assets.

Further, the FDIC's recently proposed budget for 2010 reflects a twofold increase in receivership funding over 2009, indicating that 2010 failures may exceed 2009. Already, as of January 29, 15 banks have failed this year, according to the FDIC.

"For qualified banks (generally well-capitalized and well-managed banks), acquisitions of these failed banks present new opportunities to grow aggressively -- in asset size and into new markets and geographies -- with the potential of significantly reducing the risk of such acquisitions through FDIC loss-sharing agreements," writes John Ziegelbauer, national managing partner of Grant Thornton's Financial Institutions practice. "

Deals Too Big for Some Small Banks

But don't expect a gold rush of small banks jumping into the fray, experts say, because many small banks are simply not in a position to play. "They have to be healthy enough to acquire others, to be sure that they have adequate capital levels and to make sure that they themselves are sound from a regulatory standpoint," says Rick Huff, a partner with Grant Thornton.

The process is also extremely challenging. Rigorous due diligence is required and tough decisions have to be made. "What if you do due diligence and you discover that there are more loan losses in the portfolio than you expected?" Huff asks. Besides, FDIC-assisted acquisitions require an almost immediate turnaround, a high level of banking experience and a significant amount of capital.

Such requirements would seem to be far more palatable to large banks, but they don't seem to be rushing to pick up bank remains from the graveyard.

Big Banks Have Enough Headaches

Jim Gardner, chairman of Commerce Street Capital, which advises community and regional banks on mergers and acquisitions, surmises that one reason big banks are biting is a matter of geography. "Many of the bank failures have been in Florida, Georgia and California, so if they are already represented there, there may not be much interest," Gardner says. Also, the bigger the bureaucracy, the more troublesome and complex the process, he says.

Many big banks appear to be deciding that the headaches aren't worth it right now. "Some big banks are too busy running their own institutions, focusing on their own capital and credit issues within their loan portfolios," Huff says. Their game plan for growth may be organic, by adding branches as opposed to acquisition, he adds.

One-quarter of bankers in the survey reported that they plan to acquire or build additional branches, while 75% said they planned to grow by increasing deposit share in their marketplaces. Another quarter said they had no plans for growth for the upcoming year.

So what does all this mean? "For the banking industry, this helps to solve a significant problem. It's far better than just closing banks and letting them fail. It's a better option for the FDIC," says Huff. It's also a win for acquirers.

The shakeout is likely to continue. Gardner says two years ago there were some 8,500 banks. He expects that when the dust settles, some 7,500 may be left standing. For healthy banks and other investors, this industry consolidation may indeed be good news.